Moody’s Investors Service has affirmed Albania’s B1 long-term foreign and local currency issuer ratings and the B1 foreign currency senior unsecured debt rating, with a stable outlook.
The credit ratings were affirmed given Albania’s favourable economic prospects constrained by persisting structural challenges and decelerating reform advances, the declining trajectory of the country’s debt burden and susceptibility to shock stemming from the country’s banking system and large government gross financing requirements, Moody’s said in a statement on Friday.
The decision to maintain the stable outlook reflects credit risks being broadly balanced. Albania’s macroeconomic profile and debt metrics have overall improved, but the country remains vulnerable to domestic and external shocks as well as to weaker political commitment to reform, Moody’s said.
Moody’s Investors Service also said in its statement:
Ratings Rationale Affirmation Of B1 Rating
The decision to affirm Albania’s credit rating balances the improved macroeconomic profile, progress in structural and institutional reforms and fiscal consolidation achieved in recent years against a number of persisting credit challenges that continue to weigh on the country’s credit profile. These include a small economy exposed to environmental risks with a narrow export base and limited diversification, weak fiscal metrics compared with B-rated peers and moderate susceptibility to banking system risk and, to a lesser extent, risks stemming from the government’s large financing needs reliant on the domestic banks.
FIRST DRIVER: FAVORABLE ECONOMIC PROSPECTS CONSTRAINED BY PERSISTING STRUCTURAL CHALLENGES AND DECELERATING REFORM ADVANCES
Albania’s growth dynamics have improved in recent years, and economic prospects remain favorable despite this year’s growth moderation. Real GDP expanded by 4.1% in 2018, the highest growth rate achieved in the past decade, and Moody’s projects real GDP growth of 3.6% on average in 2019-20. Economic growth is supported by solid domestic demand and gradual improvements in the export sector. However, as a small and narrowly diversified economy, Albania remains exposed to domestic and external shocks, including slower growth of its trade partners’ economies (Italy, in particular) and adverse weather conditions that can negatively affect agricultural output and the country’s electricity supply. Moreover, the recent political volatility poses a risk to the economic outlook and to the pace of structural reform implementation.
The quality of Albania’s institutions has improved in pursuit of EU accession, which is supportive of the country’s medium-term growth prospects. Notable progress has been made on judicial reform, which is ongoing, along with advancements in combating informal economy, corruption and organized crime. While progress in the areas of rule of law and property rights has improved the business environment, the prospects for private investment in the non-energy sector crucially depend on the government’s ability to maintain the reform momentum and to address the structural constraints that include weak infrastructure, skill shortages and large informality.
Progress on energy and tax system reforms has been mixed. Furthermore, the reform impetus in the energy sector has moderated since the end of the IMF program, and a number of reforms remain incomplete, in particular the liberalization of the sector and the unbundling of the energy companies. While the financial position of state-owned electricity enterprises has improved, inefficiencies in the energy sector continue to pose a risk to the economy and to the fiscal position of the government.
SECOND DRIVER: DEBT BURDEN IS ON A DECLINING TRAJECTORY BUT REMAINS HIGH RELATIVE TO B-RATED PEERS, WHILE CONTINGENT LIABILITIES ARE RISING
The debt stock decreased to just below 70% of GDP in 2018 from a high of 74% of GDP in 2015, but more recently this was mainly driven by the appreciation of the Lek versus the euro. Moody’sexpects the debt-to-GDP ratio to continue to decline over the coming years, falling below 60% of GDP by 2022. Despite being on a gradual downward trajectory, the debt level remains high relative to the median of B-rated peers (54.5% of GDP).
The fiscal deficit was 1.6% of GDP in 2018, lower than planned in the budget, but mainly as a result of under-execution of capital spending, while tax revenue underperformed. Moody’s anticipates a slower pace of fiscal consolidation than the authorities expect, mainly due to less optimistic assumptions on revenues. Moody’s forecasts the fiscal deficit to remain around 2% of GDP in the medium-term, resulting in a more gradual decline in the debt-to-GDP ratio. Furthermore, Albania’s debt dynamics are vulnerable to a negative growth shock and to a scenario of an exchange rate depreciation.
The stock of arrears has increased again since 2017 and reached about 1.9% of GDP at end-2018, although remaining below the level of 2013. The authorities set up a plan to accelerate the repayment of the arrears (mostly VAT refunds and local government arrears) over 2019 and 2020 and a strategy to prevent the creation of new arrears.
Albania faces other fiscal risks, particularly from weather-related electricity imports and contingent liabilities arising from the energy sector and public private partnerships (PPPs). In particular, the reliance on off-balance sheet financing in the form of PPPs to scale up investment has increased. As of 2018, Albania had signed PPP contracts (mostly concessions) with an estimated value of more than 30% of GDP and an additional 15% of GDP is in the pipeline. Governance and capacity issues surrounding PPPs underline the contingent liability risk.
THIRD DRIVER: SUSCEPTIBILITY TO SHOCK STEMMING FROM THE COUNTRY’S BANKING SYSTEM AND GOVERNMENT’S LARGE GROSS FINANCING REQUIREMENTS
The third driver is the country’s moderate susceptibility to banking system risk and, to a lesser extent, risks stemming from the government’s large financing needs reliant on the domestic banks. The banking system is adequately capitalized and liquid, but asset quality remains weak, despite having improved. NPLs declined to 11.4% of gross loans as of May 2019 from 18.3% at end-2016. However, about half of loans are denominated in foreign currency, in part to unhedged borrowers, pointing to asset quality risks.
Gross borrowing requirements exceeded 20% of GDP in 2018, and are expected to stay elevated in 2019-20, remaining relatively large compared to rating peers and well above the B-rated median of 8.8% of GDP in 2018. While the structure of the central government domestic debt, which accounts for about half of the total, has improved as maturity lengthened, short-term debt continues to account for about one third of the total as of end-2018, and displays a strong reliance on the domestic banking system, which holds about 60% of domestic debt. Nevertheless, government liquidity has been supported by access to external markets, with Albania successfully issuing a seven-year EUR500 million Eurobond in October 2018.
Rationale For Stable Outlook
The stable outlook balances Albania’s improved macroeconomic profile and robust growth prospects against risks arising from limited shock absorption capacity on the back of a less favorable external environment. The debt burden has declined but remains high, while Albania’s contingent liability risk has increased. Despite notable progress in strengthening the quality of institutions, Albaniacontinues to lag similarly rated peers in terms rule of law and control of corruption, while the reform impetus has slowed in certain areas, with the current political volatility posing risks to the pace of reforms.
What Could Change The Rating – Up
A material decline in public sector debt, along with a reduction of the fiscal risks posed by contingent liabilities and the energy sector, as well as further advances in strengthening institutions that results in an improved business environment and competitiveness would be credit positive.
What Could Change The Rating – Down
Downward pressure on the rating would arise from a less prudent fiscal policy or materialization of contingent liabilities leading to a reversal of the public debt-to-GDP ratio’s downward trajectory, or from a reduced political commitment to the institutional and economic reform agenda. Furthermore, the emergence of challenges in funding the current account deficit due to a significant decline of FDI would be credit negative.”